Dividend Aristocrats with Low Debt

The Occidental Petroleum dividend cut is fresh on my mind. Trust me, the wounds are deep and still open. Sadly, this was not the first time that a major, oil company in my portfolio slashed their dividend in an attempt to clean up their balance sheet. Who could forget Kinder Morgan’s infamous cut in 2015?? There was one underlying theme in both of these dividend cuts: Debt. Both companies had amassed large debt balances; debt balances that eventually became too much to handle in a time of crisis. Large debt balances are not exclusive to oil companies, sadly. Thus today, in the midst of the turbulent market and COVID-19 pandemic, I wanted to talk a little more about debt and then identify dividend stocks with low debt balances. Hopefully, this will help us find some great, undervalued Dividend Aristocrats with low debt balances to invest in!

Growing Debt on Balance sheets

We have lived in a low interest rate environment since the financial crisis. Low interest rates have encouraged individuals and corporations to borrower at cheap interest rates to various forms of investment. There are countless individuals that have locked in 30-year fixed rate mortgages at a rate below 4%. My initial interest rate was 3.89% when we purchased our house in 2017 and I was able to refinance at a rate of 3.40% in 2019 (saving nearly $50 per month in the process). Rates like these are unheard of to people my parents age. When they purchased their first home, interest rates were well over 10%!

Corporations, like individuals, have taken advantage of this low interest rate environment as well. Corporate debt continues to climb to record highs. At the end of 2019, worldwide corporate debt exceeded $13.5 trillion (Source). That is $13,500,000,000,000. Aka, a lot of zeros.

Like individuals, the low rates were supposed to jump start investment, increasing productivity, profitability, and having a very positive impact on the economy. While those activities did happen, cheap debt also allowed some companies to use debt to acquire companies and create a debt heavy balance sheet (Occidental Petroleum, Kraft-Heinz, AT&T, etc.) and to fund share repurchases and even dividend increases. Personally, I have benefited from those two scenarios a lot over the years. Heck, we cheer every dividend increase on this website. However, as we are seeing now, there are some downsides to the inflated corporate balance sheets.

When Debt can lead to a dividend cut – The Occidental Petroleum Story

Let’s circle back to the cause of my frustration, Occidental Petroleum. On the eve of their dividend cut, Lanny wrote a very detailed piece on Seeking Alpha talking about Occidental’s high dividend yield and their inevitable dividend cut (linked below). In this article, Lanny walked the readers through the perfect storm of events that led the company to their dividend cut.

Occidental Petroleum’s acquisition of Anadarko was heavily debt financed. To fund the acquisition, the company issued over $21.8b in new debt. The company managed to pay $7b in debt back before the end of 2019 and was planning on aggressively paying down the issued debt. Assuming a 6% interest rate, this new debt would result in $1.3b of interest expense annually. Remember, that is just off of “new debt” associated with the acquisition. This doesn’t even account for the remaining of the company’s outstanding debt as of the end of the year ($37.4b total, including the debt from the acquisition. This results in a projected annual interest expense of $2.2b (assuming 6%). That is a lot of interest expense right there…and that doesn’t even include principal repayments that will become due starting in 2021!

Lanny then goes on to describe the other half of the perfect storm. Once oil prices collapsed and Occidental’s revenues and income were impacted significantly. Unfortunately, regardless of the price of oil or the economic environment, the company’s debt obligations and interest expense remain the same.

Management was forced to look and find new ways to increase their cash flow. Last year, OXY paid shareholders $2.2b in dividends. The dividend cut was the most sensible way to free up the cash flow to pay their debt obligations and continue their operations. In this battle, the debt holders beat out the shareholders. Hopefully this demonstrates how high debt balances can push companies towards a dividend cut when the company faces adversity.

Dividend Aristocrats with Low Debt

The last section focused on why debt can be a problem. I would be remiss to paint corporate debt only in a bad light. Debt is not always a bad thing, if properly managed. In fact, there are many great companies out there that properly manage their balance sheet and use debt in a prudent manner.

There are many great, dividend paying stocks with low debt levels. So this article is going to identify a population of great dividend stocks with low debt balances. Lanny hit one point on the head in his last watch list. His watch list was designed with the coronavirus and turbulent markets on his mind. Focus on quality, quality, and more quality. There are plenty of great dividend growth stocks that have paid an increasing dividend over an extended period of time.

That is why I am developing my list with the following two criteria in mind: Dividend History and Debt. My goal is to keep it short and simple while providing us with a comprehensive list to use as we build our own watch lists going forward.

Criteria #1: Dividend Aristocrat – For this list, I am focusing exclusively on Dividend Aristocrats. A Dividend Aristocrat is company that has increased their dividend for 25 consecutive years. That would encompass companies that increased their dividend through the dot.com bubble and the financial crisis. We are currently in a unique economic situation with a new set of challenges. However, focusing on Dividend Aristocrats will allow me to identify the cream of the crop. The companies that have demonstrated that they know how to navigate tough economic waters while still increasing their dividend.

Criteria #2: Debt to Equity Ratio Less than .5X – The debt to equity ratio is calculated exactly how it reads, by taking a company’s total debt balance and dividing it by its total equity. Taking a step back, there are two ways that a company can finance their operations. By issuing debt or issuing equity. Both methods have pros and cons. The point of this article is not to discuss the merits of each. Rather, it is to identify companies that have used less debt to finance their operations and thus, are less prone to dividend cuts like Occidental Petroleum. A dividend cut caused by a sudden decrease in revenue, leaving the company unable to cover both their debt obligations. Using a debt to equity ratio threshold of .5X or lower indicates that a company uses a blend of debt and equity financing that is manageable and is less likely to lead to a bloated balance sheet.

The List – Dividend Aristocrats with Low Debt

I’m sure you are all eager to see how the list itself. Without further ado, here is the list of Dividend Aristocrats with low debt:

Note: Information in the chart is as of 3/18/20 close. Information obtained from www.finviz.com.

The list was eye opening for me for a few reasons.

First, of the 17 companies on this list, only 5 of the companies had dividend yields over 4%. It isn’t surprising though. The dividend yields for companies like Johnson and Johnson will not knock you off your feet. However, you know what will? The fact that the company has managed their balance sheet well and they have increased their dividend for 57 consecutive years.

Second, I own several of the companies on this list. ADM has been one of my favorite stock purchases over the last few months. JNJ is one of our Top 5 Foundation stocks and one of the three companies on Lanny’s last watch list.

Third, this is a general statement, but I can’t help but think of it every time I review this list. Man there are some great paying dividend growth stocks with very management debt to equity ratio and strong dividend yields!

Summary

Debt isn’t necessarily a bad thing. I hope that isn’t your takeaway from this article. However, poorly managed debt balances may have bad ramifications for dividend investors when times become tough. We are seeing this firsthand today. It is funny to me that this concept is not different than a family’s personal budget. In today’s tough economic environment, I wanted to help investors find quality Dividend Aristocrats with low debt balances. Now, let’s dust off our sleeves, build our watch lists, and continue pushing ourselves one step closer to financial freedom!

Do you consider debt when investing? If so, what metrics do you use and what are your thresholds? Do you think a .5X debt to equity ratio is too low and eliminates too many companies?

21 thoughts on “Dividend Aristocrats with Low Debt”

Bert, What has stood out to me for a while is TROW. Zero debt, the middle finger of the dividend champions world. A few great values on that list right now too – AFL, AOS, ADM, MDT, VFC, JNJ, TROW. I wonder how long this volatility can last… – Gremlin

Gremlin – Agree completely. I love that TROW has zero debt and has done so well growing without it. Who knows how long this volatility will last. Just when you think we turn the corner or the worst is behind us, there is a crazy new development that causes the market to swing in the other direction. Crazy times.

Finding those companies is the hard part, right? The funny thing is that you don’t know which industries are going to be impacted by a new economic crisis. 2 months ago, who would have thought the airline industry would be facing these challenges?

thanks for that list, this is really helpful at these days. I am also planning to look at stocks where a lot of insider buying is happening and maybe also move to stock with a very low dividend yield like Microsoft.

Glad you are finding it helpful! Interesting idea looking at insider training. How are you monitoring that activity? Is there a website you are using? Microsoft, Cisco, intel, and IBM are some great tech names to consider during this downturn as well.

Those would be some great names if you could add them. APD and AOS haven’t fallen as much as others, so I’m waiting a little before buying those companies. The one that jumped out to me was MDT. I may start building a position in them.

I like your thought process, the four I own from your list (ADP, BEN, JNJ, PBCT) are probably candidates for more funds in these times. My additional thought is this metric may exclude the number of companies either successfully issuing paper or drawing down their LOCs – which would inflate their ratios – to acquire and hold cash to weather the storm – as BX recently suggested their portfolio companies do.

Thank you Charlie. That is interesing. I’m sure it would take some deep diving into data and SEC filings to figure out which companies are drawing on LOC. I wonder if there is a resource that does that for you.

Congrats on lowering your mortgage rate and freeing up a little more cash each month. With the current pandemic and possibility of a continued decline, any investments you make with that extra cash will likely be indirectly worth even more than that down the road! I also love your targeted strategy of looking at dividend aristocrats with low debt. In this uncertain time period, nobody can predict how long it will be before we see a full recovery. Companies with great history and low debt levels stand the best chance of staying afloat long enough to see the recovery. These are the type of companies we are looking to add to our family’s dividend stocks portfolio as well.

Thanks for sharing your list. Best wishes and continued success to you both! AFFJ

Thank you very much. $48/month may not seem like a lot. However, it will definitely go a long way towards improving my investment portfolio. I’m glad we re sharing the same investment strategy at this time. Things are challenging, but there are still a lot of great, dividend growth stocks, with strong management teams out there.

Great post. When it comes maintaining dividend payouts, a low debt is ideal and your updated screen accounts for that. For those of us that have a long enough timeframe, the coming market will be great! I’m excited about all the things I’ll be able to buy at a discount. This, however, has been a very hard time for a friend who is very smart (a few years into being an attending doctor), but has not really understood investing. I’ve been talking over this climate with him and helping him into the type of investments that he can understand and handle the volatility.

Thank you Scott! That is awesome that you have been helping a friend improve their financial position. This is definitely a time to add some great companies at a low price. The difficult part is assessing the overall impact the virus will have on the long term economy. With that being said, this isn’t the first economic crisis, and finding companies that have been through this before and came out strong on the other end is key to investing during this time.

This is something that I’ve been meaning to start paying a lot more attention to. Granted I do so in the initial scouting, but have to admit I don’t do as well on the follow ups. The real double whammy is going to be all those share buybacks that were funded by taking on additional debt. That’s a no bueno for existing and continuing shareholders. I’m looking at you Boeing because they’re realistically going to have to do dilution of some kind whether debt or equity. Neither one is going to be good, but it’s likely coming. McDonald’s debt funded repurchases scared me off a bit and I trimmed my position a bit in mid 2019. It’s good to see that the buybacks are on hold for them now, but man just think of how much better of a position they’d be in if they hadn’t been so aggressive with the repurchases during the “good” times. Now the balance sheet is leveraged and the share price is relatively cheap but the buybacks are stopping. Rough calculations had McDonald’s ~$30 B on buybacks than was supported by FCF less the dividend during FY 2009 to FY 2018. That led to the debt to cap ratio going from ~45% to 125%. The debt is insanely cheap currently, but things could get ugly in a hurry for them. Still a great business, but I do believe that McDonald’s took things to a bit of an extreme.

That is a very important lesson and takeaway from this. I know I was always excited about the share buybacks and some of the dividend increases during the last decade. But I didn’t look close enough to see how they were funded and what type of impact the new debt would have once the economy began to sour. I think McDonalds will be able to weather the storm. Extreme, yes. But their industry may not have the same revenue impact that the airlines, Boeing, and oil are having. This will be very interesting to see how all of this shakes out. I’m learning a lot and will refine how I am looking at companies going forward.

Thanks for the list! Of those I own ADM, AFL, and JNJ. JNJ is my largest holding of the three and will probably add to it over the next couple of weeks. I used to hold TROW but actually sold that one since I am worried that its business model is or will be hurt by people’s reliance on low cost ETFs rather than the more expensive active services they offer.

Interesting. I only own two companies on that list: HRL and JNJ. I agree that debt isn’t necessarily a bad thing, but these days, I fully appreciate posture of having little to no debt, and definitely not being over leveraged.